Spring 2015

Reports of the Auditor General of Canada

REPORT 3

Tax-Based Expenditures

Office of the Auditor General of Canada

Performance audit reports

This report presents the results of a performance audit conducted
by the Office of the Auditor General of Canada under the authority
of the Auditor General Act.
A performance audit is an independent, objective, and systematic
assessment of how well government is managing its activities,
responsibilities, and resources. Audit topics are selected based on their
significance. While the Office may comment on policy implementation
in a performance audit, it does not comment on the merits of a policy.
Performance audits are planned, performed, and reported in accordance
with professional auditing standards and Office policies. They are conducted
by qualified auditors who
establish audit objectives and criteria for the assessment of performance,
gather the evidence necessary to assess performance against the criteria,
report both positive and negative findings,
conclude against the established audit objectives, and
make recommendations for improvement when there are significant
differences between criteria and assessed performance.
Performance audits contribute to a public service that is ethical and effective
and a government that is accountable to Parliament and Canadians.

The Report is available on our website at www.oag-bvg.gc.ca.

Ce document est galement publi en franais.
Her Majesty the Queen in Right of Canada, represented by
the Minister of Public Works and Government Services, 2015.
Cat. No. FA1-2015/1-3E-PDF
ISBN 978-1-100-25882-9
ISSN 1701-5413

Table of Contents
Introduction

Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Focus of the audit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Findings, Recommendations, and Responses

Informing Canadians on tax-based expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

The information provided by the Department of Finance Canada on tax-based
expenditures does not adequately support parliamentary oversight . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Analyzing proposed tax measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
For most of the tax measures we examined, the Department of Finance Canada
analyzed most key elements of its framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Evaluating existing tax-based expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
The Department of Finance Canada does not systematically evaluate all existing
tax-based expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Monitoring costs and sharing information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
The Canada Revenue Agency monitors costs and shares information with
the Department of Finance Canada . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Conclusion

18

About the Audit

19

List of Recommendations

22

Tax-Based Expenditures

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iii

Introduction
Background
Tax-based expenditures

3.1
The principal function of the tax system is to raise the revenues
necessary to fund government spending. The tax system can also be used
to achieve public policy objectives by encouraging certain behaviours (for
example, using public transit, moving to get a job, saving for retirement).
3.2
Tax measures can pursue different objectives. Many are basic
objectives of the tax system, such as better recognizing the ability of
individuals to pay, or facilitating compliance and the administration of the
tax system. Tax measures that governments use to promote specific policy
objectives are often described as tax expenditures because these
measures reduce the amount of revenue that governments would
otherwise collect. Expenditures are typically thought of as outlays or
expenses, but tax expenditures involve no such outlays. Rather, a tax
expenditure usually reduces or delays the taxes that citizens or businesses
would have paid without the underlying tax measure. Tax measures that
involve expenditures can include
tax exemptions (remove the obligation to pay tax),
deferrals (delay the payment of tax),
deductions (reduce total taxable income), or
credits (directly reduce the amount of tax payable).
3.3
Each year, the Canadian government forgoes tens of billions of
dollars in tax revenues resulting from tax expenditures. The Department
of Finance Canada does not provide an estimate of the total amount of tax
expenditures, as adding the estimated costs of individual tax expenditures
does not result in an accurate total estimate. The main reasons for not
providing a total estimated value are that the income tax rate structure is
progressive and that tax measures interact with one another. In this
regard, the Canadian position is similar to those adopted by the federal
governments of Australia and the United States.
3.4
The Department of Finance Canada takes a broad view of what
constitutes a tax expenditure. The Department identifies approximately
140 tax expenditures related to personal and corporate income tax. We
have classified these 140 tax expenditures into two subsets, the first of

Tax expenditureThe forgone tax revenues associated with a given tax measure.
Forgone tax revenuesEstimated tax revenues that the government will not receive because
of the introduction of tax measures.

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which can be considered structural or internal to the tax system. Tax

expenditures in this subset are intended to make the tax system fair and
efficient.
3.5
The second type of tax expenditure contains measures that are close
or perfect substitutes for the governments direct spending. The
Department of Finance Canada does not have an official position on
whether some tax expenditures are substitutes for direct spending. For the
purpose of this audit, we refer to these tax expenditures as tax-based
expenditures. For these measures, the government could have chosen, for
example, to send a cheque to families (direct spending) instead of
providing a tax credit (using the tax system). Depending on tax experts
interpretations, the number of tax-based expenditures for personal and
corporate income tax varies greatly.

Government spending

3.6
Government spending can be channelled through the tax system in
the form of tax measures or through direct program spending
(Exhibit 3.1). As recognized in economics literature, tax-based
expenditures operate like direct expenditures and can be used to achieve
policy goals. In fact, the International Monetary Funds Fiscal
Transparency Code states that because the government policy objectives
could be achieved alternatively through a subsidy or other direct outlays,
[tax expenditures] are regarded as equivalent to budget expenditure.

Exhibit 3.1 Main components of government spending

Government spending

Direct spending includes

Tax-based expenditures
All statutory

direct program spending,

public debt charges, and
transfers.

Budgetary spending
Voted and statutory

Focus of the audit

Non-budgetary spending
Voted and statutory

Direct program spendingThe portion of total budgetary spending that includes operating
and capital spending and grants and contributions but excludes public debt charges and
major transfers to persons and to other levels of government (as specified in the Public
Accounts).

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Reports of the Auditor General of CanadaSpring 2015

3.7
Tax-based expenditures impose a cost on governments because of
forgone revenues. Among the largest measured tax-based expenditures
in 2013 were
the low tax rate for small businesses ($2.9 billion),
the Age Credit ($2.8 billion),
the Charitable Donations Tax Credit ($2.2 billion), and
the Scientific Research and Experimental Development Investment
Tax Credit (non-refundable component: $1.8 billion).
3.8
Direct government spending is made up of budgetary expenditures
and non-budgetary expenditures that are further broken down into voted
and statutory expenditures.

Roles and responsibilities

3.9

Among other responsibilities, the Department of Finance Canada

develops and evaluates federal tax policies and legislation in the
areas of personal income tax, corporate income tax, and sales and
excise tax;
screens proposals for new tax expenditures;
evaluates the relevance and effectiveness of tax expenditures;
prepares estimates of the forgone revenues from tax expenditures;
and
monitors the effects of tax expenditures to determine unintended
revenue losses.

3.10 Canada Revenue Agency (CRA). The CRA is responsible for

administering Canadas tax laws, including the Income Tax Act.
3.11 The CRA undertakes a wide range of activities to assess and process
tax returns, information returns, and payments for individuals and
businesses. It detects non-compliance, for example, through risk assessment,
third-party data matching, verification, audits, and other means. Through
these activities, it supports the process of assessing tax returns. The Canada

Budgetary expendituresThe largest portion of the governments expenditures, including

operating and capital expenditures; transfer payments to other levels of government,
individuals, and organizations; public debt charges; and payments to Crown corporations.
Non-budgetary expendituresChanges in the composition of the financial assets of the
government, including loans, investments, and advances.
Voted spendingExpenditures voted by Parliament annually for a federal department or
agency in a particular expenditure category, such as operations, capital, or grants.
Statutory spendingExpenditures authorized under specific legislation. As they are already
approved by statute, they do not require further approval. Over 60 percent of government
spending is statutory.

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Revenue Agency advises the Tax Policy Branch of the Department of Finance
Canada if the Agency identifies issues with the legislation, both when the
legislation is being developed and once it has been implemented, if any
unforeseen issues are identified during administration.

Focus of the audit

3.12 This audit examined whether the Department of Finance Canada,
with the support of the Canada Revenue Agency and consistent with their
respective roles and responsibilities, properly manages tax-based
expenditures. We also examined whether the Department of Finance
Canada reported clear and useful information on tax-based expenditures
to support proper scrutiny by Parliament and Canadians.
3.13 This audit matters because important programs are delivered
through the tax system, and the resulting tax-based expenditures could
account for tens of billions of dollars annually. Furthermore, Parliament
requires complete information on tax-based expenditures to exercise
adequate oversight.
3.14

Exhibit 3.2 presents the tax-based expenditures that we examined.

Exhibit 3.2 Nine tax-based expenditures were audited

Scope of auditing

Analysis*

First-Time Home
Buyers Tax Credit

$115 million

Childrens Fitness Tax

Credit

$115 million

Tax-based
expenditure

Mineral Exploration
Tax Credit for
Flow-Through
Share Investors

Age Credit

$2.8 billion

$33 million

$37 million

Textbook Tax Credit

Special tax rate for
credit unions
Class 43.1 and 43.2:
material to produce
energy from
alternative
renewable sources

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Projected value
in 2013 by the
Department of
Finance Canada

Monitoring**
and
evaluation***

$40 million

Not available

Reports of the Auditor General of CanadaSpring 2015

Exhibit 3.2 Nine tax-based expenditures were audited (continued)

Scope of auditing
Tax-based
expenditure

Analysis*

Scientific Research
and Experimental
Development
(SR&ED) Investment
Tax Credit
Search and Rescue
Volunteers Tax Credit

Monitoring**
and
evaluation***

Projected value
in 2013 by the
Department of
Finance Canada
Non-refundable
component:
$1.8 billion

Not available because

the tax measure was
introduced in 2014.

* Analysis refers to the work performed by the Department of Finance Canada before a tax
measure is implemented.
** Monitoring refers to work performed after a tax measure is implemented, such as analyzing data
pertaining to the tax measure and reviewing comments from stakeholders following the
measures implementation. In addition, monitoring can include analyses on selected aspects of
tax measures, such as design, cost, or impact on low-income Canadians.
*** Evaluation refers to the reviews performed after a tax measure is implemented, where
effectiveness, equity, compliance and administration issues, and the efficiency of the means to
deliver government support are examined together to assess the ongoing relevance and
performance of the tax measure.

3.15 More details about the audit objectives, scope, approach, and criteria
are in About the Audit at the end of this report (see pages 1921).

Findings, Recommendations, and Responses

Informing Canadians on tax-based expenditures
The information provided by the Department of Finance Canada on tax-based
expenditures does not adequately support parliamentary oversight
Overall finding

Tax-Based Expenditures

3.16 Overall, in our opinion, information provided by the Department of

Finance Canada on tax-based expenditures does not adequately support
parliamentary oversight. Some information that is available for direct
program spending is not available for tax-based expenditures. For example,
the report does not include future cost projections. Also, experience abroad
provides examples where additional details related to tax-based expenditures
are disclosed or reported in a consolidated manner. We consider these
examples to represent good practices.

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3.17 This finding matters because a properly designed tax expenditure

report is critical to provide parliamentarians and Canadians with
comprehensive and consolidated information on tax expenditures and
what these expenditures are accomplishing. Also, in our opinion,
Parliament requires comprehensive and consolidated information to
effectively exercise its oversight of tax-based expenditures and understand
total government spending.
3.18 Our analysis supporting this finding presents what we examined and
discusses
the Tax Expenditures and Evaluations report,
the reports on Plans and Priorities, and
reporting practices followed in other jurisdictions.

Context

3.19 Public reporting and parliamentary oversight of government

spending are important elements of an effective tax expenditure
management system. In Canada, all government spending requires
parliamentary approval. Each year, non-statutory spending must be voted
on by Parliament by way of an appropriation act. This process allows
parliamentarians to scrutinize expenditures, ask questions, and keep the
government accountable.
3.20 Statutory expenditures are governed by specific legislation; they
represent a significant proportion of the governments spending and do
not require yearly approval by Parliament. Tax-based expenditures fall into
this category. Statutory expenditures are not subject to ongoing
parliamentary scrutiny through appropriation bills. Furthermore, unlike
direct program spending, tax expenditures are not subject to a spending
limit authorized by Parliament and may put pressure on the federal
governments finances.
3.21 Because tax expenditures are excluded from the expenditure
management system, they are not reviewed by parliamentarians. Many
subject matter experts believe that both tax expenditures and direct
program spending should be considered together. These experts also
believe that tax expenditure reporting should be included in budget
documents. For many years, the information on tax expenditures and
direct program spending has been considered separately. As a step in the
right direction, the government now publishes the two types of
information on the same day. Since 2013, the Department of Finance
Canada has published the Tax Expenditures and Evaluations report on the
day the government tables the Main Estimates.

Recommendation

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3.22 Our recommendation in this area of examination appears at

paragraph 3.33.

Reports of the Auditor General of CanadaSpring 2015

Analysis to support
this finding

3.23 What we examined. We examined whether the Department of

Finance Canada reported clear and useful information on tax-based
expenditures.
3.24 Tax Expenditures and Evaluations report. Since 1994, the
Department of Finance Canada has published tax expenditures for
personal and corporate income taxes as well as for the goods and services
tax (GST). The Department of Finance Canada Tax Expenditures and
Evaluations report presents tax expenditures, estimates of forgone
revenues, and current-year projections for many tax measures. The
information is further categorized by themes such as culture, education, or
employment.
3.25 Beginning in 2000, the tax expenditures report has been separated
into two documents. The first document, the Tax Expenditures and
Evaluations report, is published annually. It provides past years estimates
for tax expenditures as well as past and current-year projections. It also
provides research and analytical papers addressing specific tax measures.
3.26 The companion document, Tax Expenditures: Notes to the
Estimates/Projections, is a reference that presents, at the time of
publication, the existing tax expenditures and their objectives. This
document also explains how the estimates and projections are calculated.
This document is updated periodically and was last published in 2010.
3.27 We found that the annual Tax Expenditures and Evaluations report
does not include valuable information that may be available in
departments expenditure reports or in tax expenditure reports published
in some other jurisdictions. For instance, the Department of Finance
Canada does not
report on the number of beneficiaries for each tax expenditure (this
information, however, is provided in a separate table by the Canada
Revenue Agency for selected tax expenditures);
consolidate the information about the objective or purpose of each
tax expenditure every year (this information was last published
in 2010); or
publish future cost projections of its tax expenditures (this
information was last published in the 2008 report).
3.28 Reports on Plans and Priorities. The Tax Expenditures and
Evaluations report contrasts with reports on plans and priorities for direct
program spending. Reports on plans and priorities describe programs and
sub-programs and outline their expected results and their associated
resource requirements for the next three fiscal years.
3.29 Reporting practices followed in other jurisdictions. Some
international jurisdictions have adopted reporting practices that, we
believe, provide valuable information not readily available in Canada.

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3.30 Tax expenditures reports published in other jurisdictions

(for example, Australia, France, and Pennsylvania) at times include a short
description of the tax measure, a discussion of its purpose or objective, the
future cost of each tax expenditure, the number of beneficiaries, the
administrative costs, and the reliability of the estimation method, as well
as references to direct spending programs. We believe that details such as
these could improve the quality and completeness of the reporting by the
Department of Finance Canada.
3.31 In addition, in our view, those who review government spending
would gain by being able to cross-reference tax-based expenditures to
direct program spending. France offers an example of good reporting that
links tax expenditure items with direct spending under the same program
or sub-program.
3.32 There is no requirement to prepare Tax Expenditures and
Evaluations reports or to table them in Parliament. We believe that
reporting in Parliament along with the related budget documents would
greatly support parliamentary oversight.
3.33 Recommendation. To adequately support parliamentary oversight,
the Department of Finance Canada should adopt improved reporting
practices for tax-based expenditures to provide additional information,
including
cross-references of tax expenditures to direct program spending, so
that readers can understand total government spending; and
projected cost estimates in future years.
Also, in order to support parliamentary oversight, the annual Tax
Expenditures and Evaluations report should be tabled in Parliament.
The Departments response. Agreed. The Department of Finance Canada
agrees with the objective of continuously improving the information on
tax expenditures that is provided to Canadians. The Government of
Canada provides extensive information on tax expenditures through its
annual Tax Expenditures and Evaluations report. This report helps inform
the public debate on tax expenditures and contributes to transparency and
accountability. Along with its companion reference document, Tax
Expenditures: Notes to the Estimates/Projections, this report provides
valuable information to the public on the objectives, design, and actual
and projected costs of federal tax expenditures. International organizations
have recognized the quality of Canadas reporting on tax expenditures.
Starting with the next edition of Tax Expenditures and Evaluations, the
Department will provide two additional years of cost projections, to the
extent that sufficient information exists to develop reasonable projection
assumptions. The Department will also add information in the companion
reference document, Tax Expenditures: Notes to the Estimates/Projections,
to better inform readers on government spending programs.

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Analyzing proposed tax measures

For most of the tax measures we examined, the Department of Finance Canada analyzed
most key elements of its framework
Overall finding

3.34 Overall, we found that when analyzing tax-based expenditures

before they were implemented, the Department of Finance Canada
considered most key elements of its analytical framework, such as the
need for government intervention, and efficiency, effectiveness, and equity.
Analyses on potential tax measures are prepared to support the
decision-making process. It is therefore important that the Department
analyze tax measures consistently.
3.35 Our analysis supporting this finding presents what we examined and
discusses
analytical framework.

Context

3.36 Tax policy considerations such as policy need (relevance), efficiency,

effectiveness, equity, and spending alternatives, as well as forgone
revenues, are important elements to analyze before implementing a new
tax measure. These considerations are listed as best practices by
organizations such as the Organisation for Economic Co-operation and
Development and the International Monetary Fund.

Recommendations

3.37

Analysis to support
this finding

3.38 What we examined. We examined whether the Department of

Finance Canada considered key elements we had identifiedpolicy need
(relevance), efficiency, effectiveness, equity, spending alternatives, and
forgone revenueswhile analyzing the proposed tax measures before they
were implemented. We examined four measures:

We made no recommendations in this area of examination.

First-Time Home Buyers Tax Credit,

Childrens Fitness Tax Credit,
Textbook Tax Credit, and
Search and Rescue Volunteers Tax Credit.
3.39 We selected these measures because they were introduced
between 2006 and 2014. Therefore, the analysis of proposed tax measures
should have taken place during that period of time. In our opinion, these
measures could be seen as substitutes for direct program spending.

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3.40 Analytical framework. The Department of Finance Canada has a

framework to analyze tax-based expenditures before they are implemented.
According to the Department, the analysis of proposals for new tax
measures is tailored to the context, and it is not always relevant to include
all the elements of the analytical framework. The Department indicated
that the following elements may be considered when analyzing a given tax
issue or a proposed tax change:
relevance, taking into account government support and actions in a
given area (that is, does a tax measure have a clearly identified and
sound rationale? Does it answer a real policy need?);
consistency with government priorities and roles and responsibilities
of the federal government;
effectiveness in achieving its policy objective(s);
economic (efficiency) impacts;
impact on different groups of taxpayers (for example, by income class
or industry);
equity and impact on fairness of the tax system;
cost and revenue impact and long-term fiscal sustainability;
legislative feasibility;
impact on complexity of the tax system;
impact on compliance and administrative costs;
vulnerability to tax planning, avoidance, and evasion;
potential provincial, territorial, or international impacts;
gender and environmental impacts; and
existence of alternative means (including non-tax measures and
programs) to achieve the same objectives more efficiently.
3.41 For the purpose of our audit, we selected the following elements:
policy need (relevance), efficiency, effectiveness, equity, spending
alternatives, and forgone revenues.
3.42 We found that the Department analyzed the issues related to policy
need, efficiency, effectiveness, equity, and forgone revenues for most of the
selected tax measures. However, the Department did not consider
spending alternatives for the tax measures we examined.

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Evaluating existing tax-based expenditures

The Department of Finance Canada does not systematically evaluate all existing tax-based
expenditures
Overall finding

3.43 Overall, we found that the Department of Finance Canada

monitored all selected tax-based expenditures. However, the Department
did not systematically evaluate all tax-based expenditures. Also,
evaluations prepared by the Department were generally not published.
3.44 We found examples where the Department of Finance Canada
identified issues in relation to certain tax measures before implementing
them. Despite those issues, the Department had yet to evaluate these tax
measures.
3.45 Regular evaluations of all tax-based expenditures are important,
since circumstances leading to their implementation can change. For
example, according to the Department, measures that were implemented
to support a declining economy should be reviewed when macroeconomic
conditions improve.
3.46 Our analysis supporting this finding presents what we examined and
discusses
monitoring,
evaluation planning,
evaluations,
tax measures that were analyzed and evaluated,
tax measures that were analyzed and not evaluated, and
published research information on tax expenditures.

Context

Tax-Based Expenditures

3.47 Evaluation requirements for direct program spending. Direct

program spending is subject to the Treasury Board Policy on Evaluation
published in 2009. Officials from the Treasury Board of Canada
Secretariat informed us that the 2009 policy was developed to support the
Expenditure Management System, including strategic reviews that
addressed 100 percent of direct program spending and the operating costs
of an organizations major statutory programs. The policy requires
departments to evaluate all direct program spending over a five-year cycle.
The policy defines evaluation as the systematic collection and analysis of
evidence on the outcomes of programs to make judgments about their
relevance, performance, and alternative ways to deliver them or to achieve
the same results. This requirement to evaluate programs does not apply to
transfers and public debt charges.

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3.48 Evaluation requirements for tax-based expenditures. While the

administrative aspects of tax expenditures may be evaluated by the
Canada Revenue Agency as part of its risk-based audit and evaluation
plan, the policy requirement to evaluate programs does not apply to
tax-based expenditures. Tax expenditures are the Department of Finance
Canadas responsibility. These expenditures are not covered by Treasury
Boards evaluation policy. Also, while some tax expenditures have been
reviewed and modified by the government, tax expenditures are not
subject to strategic reviews.
3.49 Exhibit 3.3 compares the approval and review processes of direct
program spending and tax-based expenditures.
Exhibit 3.3 Comparison of direct program spending and tax-based expenditures for approvals and
reviews
Attribute

Direct program spending

Tax-based expenditures

Cabinet and ministerial approval

Memorandum to Cabinet,
Treasury Board submission

Briefing notes prepared for

the Minister of Finance and the
Prime Minister

Maximum value of the measure

Total authorities granted by

Parliament through an
appropriation act

No maximum

Approval by Parliament

Parliamentary scrutiny and approval

of Estimates each year by annual
appropriation act

Approved in the Budget

Implementation Act or other statutes

Evaluation

Required every five years,

according to the Treasury Board
Policy on Evaluation

No requirements

Subject to expenditure reviews

Yes

No

3.50 Since the 201213 fiscal year, the government has adopted a new
accounting standard. Under this new standard, most refundable tax
credits are reclassified as part of direct program spending. The Treasury
Board of Canada Secretariat has advised us that refundable tax credits are,
however, not covered by its Policy on Evaluation. The Policy applies to
direct program spending as reported in the Estimates. Accounting
standards continue to treat non-refundable tax-based expenditures
differently from direct program spending.
Non-refundable tax creditsNon-refundable tax credits are deducted from the taxes owed
by taxpayers to the government. When the credits exceed the taxes owed, the excess is not
refundable to taxpayers.
Refundable tax creditsLike non-refundable tax credits, refundable tax credits are
deducted from the taxes owed by taxpayers to the government. In contrast, however, when
the credits exceed the taxes owed, the excess is refundable to taxpayers.

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Recommendations

3.51 Our recommendations in this area of examination appear at

paragraphs 3.61 and 3.63.

Analysis to support
this finding

3.52 What we examined. We examined the process the Department of

Finance Canada used to monitor and evaluate tax measures. We also
examined the extent to which the Department of Finance Canada
evaluated the measures we examined. We wanted to ensure that
evaluations included these key elements:
an evaluation of effectiveness (that is, a comparison of policy
outcomes with objectives);
equity;
implementation costs and compliance issues for the tax
administration;
efficiency of delivery; and
frequency of evaluation.
3.53

We selected eight measures:

First-Time Home Buyers Tax Credit,

Childrens Fitness Tax Credit,
Mineral Exploration Tax Credit for Flow-Through Share Investors,
Age Credit,
Textbook Tax Credit,
Special tax rate for credit unions,
Class 43.1 and 43.2: material to produce energy from alternative
renewable sources, and
Scientific Research and Experimental Development (SR&ED)
Investment Tax Credit.
3.54 We selected these measures because they have been implemented
long enough that the Department of Finance Canada could have evaluated
them between 2008 and 2014. In our opinion, these measures could be
seen as substitutes for direct program spending.
3.55 Monitoring. According to the Organisation for Economic
Co-operation and Development, it is good practice to monitor the
effects of a tax measure and use that information to evaluate the
measure formally. For the purpose of this audit, we define monitoring as
analyzing data pertaining to the tax measure and reviewing comments
from stakeholders following the measures implementation. In addition,
monitoring can include analyses on selected aspects of tax measures

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13

such as design, cost, or impact on low-income Canadians. The

Department of Finance Canada provided evidence showing that it
monitored all selected tax-based expenditures.
3.56 Evaluation planning. For the purpose of this audit, evaluations
are the reviews performed after the implementation of the tax measure
where effectiveness, equity, compliance and administration issues, and
the efficiency of the means to deliver the government support are
examined together to assess the ongoing relevance and performance of
the tax measure. This periodic evaluation is similar to the practice used
to review direct program spending.
3.57 We found that the Department establishes annual and
medium-term work plans for evaluation work to be done on various topics
and to be potentially published in its annual report. According to the
Department, the same elements listed in paragraph 3.40 could be
considered when evaluating existing tax measures. The Department
chooses measures to review according to current priorities and issues of
interest. Work plans are influenced by comments the Department receives
from stakeholders on potential and existing tax expenditures.
3.58 Evaluations. We found that the Department did not evaluate four
of the eight measures that we examined:
Mineral Exploration Tax Credit,
Age Credit,
Textbook Tax Credit, and
First-Time Home Buyers Tax Credit.
While the Department monitored these credits, not all elements related to
these tax measures were assessed together. In our view, the monitoring of
selected issues does not constitute an evaluation, since it does not provide
a complete set of information regarding the ongoing relevance and overall
performance of tax measures.
3.59 Tax measures that were analyzed and evaluated. We found that
the Department was aware of some issues regarding the design of the
Childrens Fitness Tax Credit prior to implementation in 2007. An Expert
Panel appointed in 2006 to advise the Department on the credits design
raised a concern that some parents may lack the means to pay for
membership fees, programs, or camps. The Panel requested that, after
four years of implementation, the Childrens Fitness Tax Credit be
reviewed. We found that the Department prepared an appropriate
evaluation in 2013 in response to the Expert Panel. This information
was not made public.
3.60 Tax measures that were analyzed and not evaluated. Regarding
the Textbook Tax Credit, we found that the Department identified
some possible design issues before the credits implementation.

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The Department estimated the projected impact of the Textbook Tax

Credit on full-time and part-time students by level of income. The
Department also considered the cost of expanding the existing Education
Tax Credit as an alternative to introducing the Textbook Tax Credit. For
the First-Time Home Buyers Tax Credit, we found that the Department
identified some risks regarding this tax credit that the government had
introduced to stimulate housing demand during the financial turmoil
in 2009. We found that the Department did not evaluate these two tax
credits years after their implementation, despite possible issues that it
identified. In fact, the Department indicated that based on its monitoring,
there was little need to evaluate the First-Time Home Buyers Tax Credit
and the Textbook Tax Credit. The Department does not have complete
information to determine if these tax measures are relevant and
performing as intended.
3.61 Recommendation. The Department of Finance Canada should
conduct systematic and ongoing prioritized evaluations of all tax-based
expenditures, similar to what all departments and agencies are required to
do for direct program spending. These evaluations should include
assessing the measures ongoing relevance and appropriateness;
determining whether the tax system is the most effective and
efficient way to meet policy objectives and deliver outcomes; and
establishing whether to abolish, modify, replace, or retain the
tax-based expenditure.
The Departments response. Agreed. The Department of Finance Canada
agrees that tax expenditures should be properly evaluated. Consistent with
the Departments responsibility of supporting the Minister of Finance in
the development of tax policy, the Department analyzes all key aspects of
all measures prior to their implementation and monitors and evaluates the
key aspects of existing tax expenditures on an ongoing basis.
Since 2006, more than one third of all existing income tax expenditures
were either adopted or modified to some extent.
Tax expenditures differ from spending programs. The Departments
approach to the evaluation of tax expenditures is tailored to their
characteristics, and takes into consideration how these interact with the
overall tax system, notably interactions among tax measures, tax policy
objectivesfor example, fairness, competitiveness, and simplicityas
well as provincial and international considerations, fiscal implications,
potential market reactions, and system integrity.
Going forward, the Department will document the process by which it
regularly and systematically reviews all tax expenditures. Evaluations will
be prioritized on the basis of any gaps identified in the analysis conducted
by the Department.

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3.62 Published research information on tax expenditures. The

Department publishes some of its research in the Tax Expenditures and
Evaluations report. For the eight measures we audited, one research paper
has been released in the Tax Expenditures and Evaluations report
since 2008. The document on accelerated capital cost allowance (CCA)
attempted to estimate tax expenditures related to accelerated CCA for
assets in Class 43.1 and 43.2. This document did not, however, evaluate
the measure. Since 2009, the Department of Finance Canada has
published one evaluation in the annual report not related to our sample of
measures. In addition, the Expert Panel on Research and Development,
mandated by the government, published a report that included an
evaluation of the Scientific Research and Experimental Development
Investment Tax Credit in 2011.
3.63 Recommendation. Similar to reporting for direct program
spending evaluations, the Department should publish, in a timely
manner, pertinent information for all tax-based expenditure programs
that have been evaluated to facilitate consideration by parliamentarians
and Canadians on the ongoing relevance and performance of
tax-based expenditures.
The Departments response. Agreed. The Department of Finance Canada
agrees with the objective of continuously improving the public information
available on tax expenditures. The Department has been proactive in
providing valuable and detailed information on tax expenditures to
parliamentarians and the public at large, in particular through its Tax
Expenditures and Evaluations report. In recent years, the Department
published five analytical papers on the eight tax expenditures that the
audit team reviewed. Evaluations of the administrative aspects of tax
expenditures are also made public by the Department and the Canada
Revenue Agency. Canada is one of a handful of countries that publishes
evaluations of tax expenditures on a regular basis.
The Department will make sure that high-quality analyses and
evaluations of tax expenditures continue to be performed and that
pertinent information be made available to the public as appropriate.

Monitoring costs and sharing information

The Canada Revenue Agency monitors costs and shares information with the Department
of Finance Canada
Overall finding

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3.64 Overall, we found that the Canada Revenue Agency (CRA) monitors
costs to implement new measures, including the impact of the measure on
provincial or territorial administrations, on its own internal operations, or
on its publications. It also monitors compliance issues and shares relevant
information with the Department of Finance Canada on an ongoing basis.

Reports of the Auditor General of CanadaSpring 2015

3.65 This finding is important because policy makers need to consider

administrative costs and compliance issues when making decisions about
tax policies. The ongoing exchange of information, on a timely basis, is
critical to ensure that tax-based expenditures are designed properly and
minimize administrative costs and compliance issues.
3.66 Our analysis supporting this finding presents what we examined and
discusses
monitoring administrative and compliance issues, and
providing advice to the Department of Finance Canada.

Context

3.67 The design and implementation of a new tax measure can

directly affect the tax systems complexity and the costs of administration
and compliance.
3.68 When the Department of Finance Canada is developing a new
tax-based expenditure, the CRA evaluates whether the Agency needs
supplementary funding to cover additional administrative costs or
whether it can simply absorb the costs. The Agency requests additional
funding when incremental costs exceed its ability to manage the new tax
measure within existing funding levels. In these cases, Agency officials
examine the possibility of obtaining additional funding through the
regular Treasury Board submission process. In many cases, the additional
funding comes from modifications to existing tax measures and is
requested through Treasury Board omnibus submissions. These
submissions are part of the governments budget for a given year.

We made no recommendations in this area of examination.

Recommendations

3.69

Analysis to support
this finding

3.70 What we examined. We examined whether the Department of

Finance Canada, with the support of the Canada Revenue Agency and
consistent with their respective roles and responsibilities, assessed
administrative and compliance issues as well as enforceability before
putting tax-based expenditures in place. We also examined whether the
Department of Finance Canada, with the support of the Canada Revenue
Agency and consistent with their respective responsibilities, considered
information about potential compliance issues and implementation costs
of tax-based expenditures.
3.71 Monitoring administrative and compliance issues. We found
that the Canada Revenue Agency monitors administrative and
compliance issues for the tax administration concerning specific tax-based
expenditures and shares information with the Department of Finance
Canada on an ongoing basis.

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3.72 We found that the Canada Revenue Agency examines the impacts of
changes to tax measures on a number of operational aspects. For instance,
the Agency examines the impact of the measure on provincial or territorial
administrations, on its own internal operations, or on its publications.
The Canada Revenue Agency also examines required changes to its IT
systems, the number of taxpayers affected, and the expected number of
inquiries the tax measure change will generate.
3.73 According to the Canada Revenue Agency, adding just one line to
the T1 tax return related to a new non-refundable tax credit can involve
significant effort and costs the Agency up to $1 million, based on similar
costs for other standard tax measures. This expense is due to additional
work, such as
the information technology (IT) coding requirements to create the
necessary data fields, and
the administration of the additional information that helps the
Agency collect data and process claims.
As well, incremental costs may result from measures that involve a high
number of claimants (such as additional general enquiries, verification
activities, objections, appeals).
3.74 Providing advice to the Department of Finance Canada. We found
that Canada Revenue Agency officials suggested modifications and design
improvements and advised on certain measures where applicable or
answered queries about these measures.
3.75 Most exchanges regarding new tax measures or amendments to
existing ones take place under tight timelines in the pre-Budget period.
These exchanges typically occur informally, but in some cases, the Canada
Revenue Agency prepares a more thorough analysis to formulate advice,
suggest changes to a specific measure, or make a recommendation to the
Department of Finance Canada.
3.76 After a tax measure has been implemented, the Canada Revenue
Agency usually provides the Department of Finance Canada with
comments and analysis on unforeseen effects such as compliance issues or
additional costs related to the tax measure.

Conclusion
3.77 While the Department of Finance Canada had appropriate practices
to analyze new tax measures, to monitor existing tax-based expenditures,
and to share information with the Canada Revenue Agency, overall
we concluded that the Department fell short on managing tax-based
expenditures. We reached this conclusion because these expenditures
were not systematically evaluated and the information reported did not
adequately support parliamentary oversight.

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About the Audit

The Office of the Auditor Generals responsibility was to conduct an independent examination of
tax-based expenditures to provide objective information, advice, and assurance to assist Parliament in
its scrutiny of the governments management of resources and programs.
All of the audit work in this report was conducted in accordance with the standards for assurance
engagements set out by the Chartered Professional Accountants of Canada (CPA) in the CPA Canada
HandbookAssurance. While the Office adopts these standards as the minimum requirement for our
audits, we also draw upon the standards and practices of other disciplines.

Objectives
The audit examined whether the Department of Finance Canada, with the support of the Canada
Revenue Agency and consistent with their respective roles and responsibilities, properly manages
tax-based expenditures. As part of this objective, we sought
to determine whether the Department of Finance Canada, with the support of the Canada
Revenue Agency and consistent with their respective roles and responsibilities, appropriately
analyzed tax-based expenditures before their implementation;
to determine whether the Department of Finance Canada, with the support of the Canada
Revenue Agency and consistent with their respective roles and responsibilities, appropriately
monitored and evaluated existing tax-based expenditures; and
to determine whether the Department of Finance Canada reported clear and useful information
on tax-based expenditures.

Scope and approach

The scope of this audit included the Tax Policy Branch of the Department of Finance Canada and the
Canada Revenue Agency. The scope was limited to personal and corporate income tax measures
involving tax-based expenditures. The audit excluded tax expenditures related to the goods and
services tax (GST) and omitted measures that are, in our view, structural or internal to the tax system
(for example, tax-free savings accounts and pension income splitting). Finally, the audit did not
examine the models used by the Department of Finance Canada to determine the estimated or
projected costs of particular tax expenditures.
We looked at how the need for tax-based expenditures was identified and how they were analyzed. The
audit examined how the Department of Finance Canada considered alternative spending options as
well as effectiveness, equity, efficiency, and forgone revenues. The audit also examined how the
Canada Revenue Agency exchanged information with the Department of Finance Canada regarding
implementation costs of new tax measures and related compliance issues.
We examined whether tax-based expenditures were monitored on an ongoing basis and were
periodically evaluated following implementation.
We also examined the reporting of information on tax-based expenditures.

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For the Department and the Agency to demonstrate that tax-based expenditures are managed
properly, we sought information and analyses regarding the following tax measures:
First-Time Home Buyers Tax Credit,
Childrens Fitness Tax Credit,
Mineral Exploration Tax Credit for Flow-Through Share Investors,
Age Credit,
Textbook Tax Credit,
Search and Rescue Volunteers Tax Credit,
Special tax rate for credit unions,
Class 43.1 and 43.2: material to produce energy from alternative renewable sources, and
Scientific Research and Experimental Development (SR&ED) Investment Tax Credit.
We chose these measures because they are substitutes for direct program spending; they are not
structural tax expenditures. Four measures have been developed since 2006, and eight measures have
been implemented for more than five years. We were therefore able to select four measures for
analysis before their implementation and eight measures for the evaluations.

Criteria
Criteria

Sources

To determine whether the Department of Finance Canada, with the support of the Canada Revenue Agency and
consistent with their respective roles and responsibilities, appropriately analyzed tax-based expenditures
before their implementation, we used the following criteria:
The Department of Finance Canada analyzed tax
measures against need, efficiency, effectiveness, and
equity.

Choosing a Broad BaseLow Rate Approach to

Taxation, Organisation for Economic Co-operation
and Development (OECD), 2010
The Green Book: Appraisal and Evaluation in Central
Government, United Kingdom HM Treasury, July 2011

The Department of Finance Canada assessed the costs

and benefits of delivery options.

Choosing a Broad BaseLow Rate Approach to

Taxation, OECD, 2010
The Green Book: Appraisal and Evaluation in Central
Government, United Kingdom HM Treasury, July 2011

The Department of Finance Canada assessed forgone

revenues.

Choosing a Broad BaseLow Rate Approach to

Taxation, OECD, 2010
The Process for Making Tax Policy in Canada, Brian
Ernewein and Nancy Horsman, Canadian Tax Journal,
2013
The Green Book: Appraisal and Evaluation in Central
Government, United Kingdom HM Treasury, July 2011

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Criteria

Sources

To determine whether the Department of Finance Canada, with the support of the Canada Revenue Agency and
consistent with their respective roles and responsibilities, appropriately analyzed tax-based expenditures
before their implementation, we used the following criteria: (continued)
The Department of Finance Canada, with the support of
the Canada Revenue Agency, and consistent with their
respective roles and responsibilities, assessed
administrative and compliance issues as well as
enforceability.

Forum on Tax Administration: Working smarter in

structuring the administration, in compliance, and
through legislation, OECD, 2012

To determine whether the Department of Finance Canada, with the support of the Canada Revenue Agency and
consistent with their respective roles and responsibilities, appropriately monitored and evaluated existing
tax-based expenditures, we used the following criteria:
The Department of Finance Canada appropriately
monitored and evaluated tax-based expenditures on an
ongoing basis.

Tax Expenditures in OECD Countries, OECD, 2010

Fiscal Monitor, Appendix 5, International Monetary
Fund, April 2011
Treasury Board Policy on Evaluation, Treasury Board of
Canada Secretariat, 2009

The Department of Finance Canada, with the support of

the Canada Revenue Agency, and consistent with their
respective responsibilities, considered information in
regard to potential compliance issues and
administrative costs of existing tax-based expenditures.

Forum on Tax Administration: Working smarter in

structuring the administration, in compliance, and
through legislation, OECD, 2012

To determine whether the Department of Finance Canada reported clear and useful information on tax-based
expenditures, we used the following criteria:
The Department of Finance Canada reported clear and
useful information on tax-based expenditures (including
forgone revenues, evaluation results, and link with direct
program spending).

Best Practice Guidelines Off Budget and Tax

Expenditures, Working Party of Senior Budget
Officials, OECD, 2004

Management reviewed and accepted the suitability of the criteria used in the audit.

Period covered by the audit

The audit covered the period between 1 April 2008 and 31 March 2014. The period under
examination was extended back to 1 January 2006 when examining the analysis of tax measures
before implementation. Audit work for this report was completed on 22 January 2015.

Audit team
Assistant Auditor General: Nancy Y. Cheng
Principal: Richard Domingue
Director: Philippe Le Goff
Sbastien Defoy
Rose Pelletier

Tax-Based Expenditures

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List of Recommendations
The following is a list of recommendations found in this report. The number in front of the
recommendation indicates the paragraph where it appears in the report. The numbers in parentheses
indicate the paragraphs where the topic is discussed.
Recommendation

Response

Informing Canadians on tax-based expenditures

3.33
To adequately support
parliamentary oversight, the Department
of Finance Canada should adopt
improved reporting practices for
tax-based expenditures to provide
additional information, including
cross-references of tax expenditures to
direct program spending, so that
readers can understand total
government spending; and
projected cost estimates in future years.
Also, in order to support parliamentary
oversight, the annual Tax Expenditures
and Evaluations report should be tabled
in Parliament. (3.233.32)

The Departments response. Agreed. The Department of Finance

Canada agrees with the objective of continuously improving the
information on tax expenditures that is provided to Canadians. The
Government of Canada provides extensive information on tax
expenditures through its annual Tax Expenditures and Evaluations
report. This report helps inform the public debate on tax expenditures
and contributes to transparency and accountability. Along with its
companion reference document, Tax Expenditures: Notes to the
Estimates/Projections, this report provides valuable information to
the public on the objectives, design, and actual and projected costs of
federal tax expenditures. International organizations have recognized
the quality of Canadas reporting on tax expenditures.
Starting with the next edition of Tax Expenditures and Evaluations,
the Department will provide two additional years of cost projections,
to the extent that sufficient information exists to develop reasonable
projection assumptions. The Department will also add information in
the companion reference document, Tax Expenditures: Notes to the
Estimates/Projections, to better inform readers on government
spending programs.

Evaluating existing tax-based expenditures

3.61
The Department of Finance
Canada should conduct systematic and
ongoing prioritized evaluations of all
tax-based expenditures, similar to what all
departments and agencies are required to
do for direct program spending. These
evaluations should include
assessing the measures ongoing
relevance and appropriateness;

Since 2006, more than one third of all existing income tax
expenditures were either adopted or modified to some extent.

determining whether the tax system is

the most effective and efficient way to
meet policy objectives and deliver
outcomes; and

Tax expenditures differ from spending programs. The Departments

approach to the evaluation of tax expenditures is tailored to their
characteristics, and takes into consideration how these interact with
the overall tax system, notably interactions among tax measures, tax
policy objectivesfor example, fairness, competitiveness, and
simplicityas well as provincial and international considerations,
fiscal implications, potential market reactions, and system integrity.

establishing whether to abolish,

modify, replace, or retain the tax-based
expenditure. (3.523.60)

22

The Departments response. Agreed. The Department of Finance

Canada agrees that tax expenditures should be properly evaluated.
Consistent with the Departments responsibility of supporting the
Minister of Finance in the development of tax policy, the Department
analyzes all key aspects of all measures prior to their implementation
and monitors and evaluates the key aspects of existing tax
expenditures on an ongoing basis.

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Reports of the Auditor General of CanadaSpring 2015

Recommendation

Response
Going forward, the Department will document the process by which
it regularly and systematically reviews all tax expenditures.
Evaluations will be prioritized on the basis of any gaps identified in
the analysis conducted by the Department.

3.63
Similar to reporting for direct
program spending evaluations, the
Department should publish, in a timely
manner, pertinent information for all
tax-based expenditure programs that
have been evaluated to facilitate
consideration by parliamentarians and
Canadians on the ongoing relevance and
performance of tax-based expenditures.
(3.62)

The Departments response. Agreed. The Department of Finance

Canada agrees with the objective of continuously improving the
public information available on tax expenditures. The Department
has been proactive in providing valuable and detailed information on
tax expenditures to parliamentarians and the public at large, in
particular through its Tax Expenditures and Evaluations report. In
recent years, the Department published five analytical papers on the
eight tax expenditures that the audit team reviewed. Evaluations of
the administrative aspects of tax expenditures are also made public
by the Department and the Canada Revenue Agency. Canada is one
of a handful of countries that publishes evaluations of tax
expenditures on a regular basis.
The Department will make sure that high-quality analyses and
evaluations of tax expenditures continue to be performed and that
pertinent information be made available to the public as appropriate.

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